Good day, and welcome to the Capital Senior Living Second Quarter 2014 Earnings Release Conference Call. Today's conference is being recorded.

The forward-looking statements in this release are subject to certain risks and uncertainties that could cause results to differ materially, including, but not without limitation to, the company's ability to find suitable acquisition properties at favorable terms; financing; licensing; business conditions; risks of downturns and economic conditions generally; satisfaction of closing conditions such as those pertaining to licensure; availability of insurance at commercially reasonable rates; and changes in accounting principles and interpretations, among others; and other risks and factors identified from time to time in our reports filed with the Securities and Exchange Commission.

At this time, I'd like to turn the call over to Mr. Larry Cohen. Please go ahead, sir.

Larry Cohen

Thank you. Good afternoon, and welcome to Capital Senior Living's second quarter 2014 earnings release conference call. I am pleased to report positive results for the second quarter with growth in revenue, occupancy, EBITDAR and CFFO. Complementing this growth is a robust pipeline that allows us to continue our disciplined and strategic acquisition program that increases our ownership of high quality senior living communities in geographically concentrated regions and generates meaningful increases in CFFO, earnings and real estate value.

In the second quarter, we completed the acquisition of three senior living communities from our Ohio joint venture in which we’ve previously held a 10% interest or approximately $83.6 million. Two of the communities were financed with approximately $40.1 million of nonrecourse 10-year mortgage debt with a blended fixed interest rate of 4.41%. One community was financed with a $21.6 million two-year bridge loan with the variable interest rate of approximately 2.9%, net of management fees of approximately $900,000 and our portion of JV net income of approximately $200,000, this acquisition is expected to add adjusted CFFO of $0.11 per share, increase annual revenue by $16.9 million and add $6.8 million of EBITDAR.

Yesterday, we completed the acquisition of two senior living communities for a combined purchase price of $33.9 million. These communities add to our operations in Virginia and Wisconsin. They were financed with approximately $26.2 million of nonrecourse 10-year mortgage debt and a blended fixed interest rate of 4.59%. This acquisition is expected to add adjusted CFFO of $0.04 per share, increase annual revenue by $8.2 million and add $2.9 million of EBITDAR. We are conducting due diligence on additional acquisitions of high quality senior living communities in states with existing operations and subject to customary closing conditions expect to close in acquisitions of approximately $13.5 million by the end of the third quarter.

With this additional acquisition, we will have acquired seven communities for a combined purchase price of $145.6 million through the first three quarters of the year. These 2014 acquisitions are expected to generate greater than a 17% cash on cash return. Our second quarter same community revenue increased 1% compared to the second quarter of 2013 reflecting the cumulative effect of competitive pricing in 2013 while we dealt with higher levels of attrition. Here’s what we’re doing to improve this.

In the near term, we are using introductory specials at lower occupancy communities, we are increasing rates at higher occupancy communities, increasing level of care charges where we can and moderating rate increases throughout the company. Longer term, we are refurbishing communities and converting units to higher levels of care to gain occupancy, reduce attrition and increase rates. And we are encouraged by some of the same community improvement we saw in the second quarter.

We have implemented many initiatives that already are yielding positive results and we believe will further enhance our operations moving forward, including our integrated marketing program, a new responsive website and e-marketing campaign, an expansion of our search engine optimization strategies such as the implementation of pay per click. In addition, we are utilizing the software programs at our assisted living communities that are helping us to optimize care plans and level of care charges as well as enhanced training and adherence to quality assurance. We are also encouraged by the positive results from our call centers that were initiated at many of our communities earlier this year.

We have also enhanced our private-pay revenues by closing the only skilled nursing beds we had operated in two continuing care retirement communities. I’m excited about the very attractive design plans that had been developed to reposition these two communities which include the addition of 56 memory care units in the space previously occupied for skilled nursing in the first half of 2015 as well as adding more interesting and appealing spaces for all of our residents, such as additional dining venues, Internet café, media room, theater and conversation clusters at each of the communities. We are awaiting permits for these projects and expect construction to begin in the fourth quarter of this year. While these two communities are being repositioned, they will be excluded from same community results.

In the second quarter of 2014, our same community average rent increased over the first quarter of 2014 by an annualized rate of nearly 3% to $3,141 per occupied unit and our same community occupancy increased 20 basis points from the first quarter of 2014. Second quarter 2014 same community occupancy increased 30 basis points compared to the same period in 2013. This is the first year-over-year same community occupancy increase since the second quarter of 2013.

On a same community basis, second quarter 2014 move-ins increased 12%, deposits increased 13% and tours increased 7% compared to the second quarter of 2013. These results encourage us about the second half of the year. We are focused on reducing attrition, improving occupancy and increasing cash flow by offering residents the ability to age in place through the conversion of approximately 360 vacant independent living units to assisted living and memory care at 15 communities.

We have received required licensure approval and expect to receive additional licensure approvals for half these conversions during the third and fourth quarter of this year with the balance of approvals expected to be received during the first half of 2015. Once these converted units are stabilized, we expect overall occupancy to increase by approximately 300 basis points to 90%. And once stabilized, these converted units are expected to add approximately $0.20 in annual CFFO and enhance the value of owned real estate.

Additional conversions are planned for the second half of 2015. We have a successful track record in converting vacant, independent living units to assisted living and memory care, conversions of larger residential independent living units with full kitchens, walk-in closets and one or two bedroom apartments provide our communities with a competitive advantage over smaller purpose-built assisted living units. Prior conversions of independent living apartments to assisted living and memory care units have been very well received and is demonstrated by occupancy gains of 10 percentage points at these communities.

Industry fundamentals continue to be solid with demand outpacing supply. NIC MAP reported favorable supply/demand trends for independent and assisted living communities during the second quarter of 2014 with positive unit absorption to supply. As we have discussed on previous calls, new construction has been needed in most of our markets confirming that our values strategy with average monthly rents of $3,175 acts as an economic barrier to entry for new developments with replacement costs averaging in excess of $175,000 per unit. Rents would have to be about 50% higher than current levels in most of our markets to generate a reasonable return on the cost of development, indicating the opportunity to realize significant rent growth before we expect to see new construction in these markets.

With strong industry fundamentals, an improving economy and housing market and virtually no new supply in our markets, we believe that our properties can grow to an optimal level of 92% to 93%, providing significant opportunity for additional organically driven CFFO growth and increases in our real estate values. Every 1% improvement in occupancy is expected to generate $4 million of revenue, $2.8 million of EBITDAR and $0.06 per share of CFFO.

We are also looking to improve the quality of our portfolio and increase our liquidity by selling certain noncore communities. We expect that selected asset sales in 2014 will improve our operating metrics and allow us to redeploy the proceeds to acquire better-performing communities in our geographically concentrated regions. Our operating strategy is to provide value to residents by providing quality senior living services at reasonable prices. We believe our competitive advantage that allows us to achieve solid operating results and disciplined growth is our people and our culture.

We continue to execute on a strategic plan that is focused on a very important objective of enhancing shareholder value through organic growth, proactive expense management and utilization of technology as well as allocating capital to accretive acquisitions of high quality senior living communities in our geographically concentrated regions, unit conversions and community refurbishments. As we maximize our competitive strengths, we are lowering our cost of capital.

We are growing through a disciplined and strategic acquisition program that began in 2011 and which has been funded from internally generated cash flow. In the past three years, we have acquired 41 communities for a combined purchase price of nearly $550 million. These acquisitions have generated a 16.3% cash on cash return. Our success in acquiring quality communities in off-market, non-broker transactions validates our competitive advantage as a highly respected and credible owner-operator with the financial ability to complete transactions.

90% of the communities we have acquired or expect to acquire in 2014 are off-market transactions. Many local and regional operators tell us that they prefer to transact with Capital Senior Living as they feel comfortable in trusting their residents and staff to the Capital Senior Living family. More than 50% of the communities we purchased in 2013 and 2014 are with sellers with whom we have completed previous transactions.

As our cash flow continues to grow and our liquidity improves from our recent refinancing and planned asset sales, our robust pipeline provides us with ample quality acquisition opportunities in a highly favorable financing market. We are excited about continuing our successful acquisition program in 2014 and in future years. We are well-positioned for growth in both the near term and long term. Our strategies are solid and I am optimistic about the company’s prospects as we benefit from our substantially all private-pay strategy in an industry that is benefiting from need-driven demand, limited new supply and an improving economy and housing market.

I would now like to introduce Carey Hendrickson, our Chief Financial Officer, to review the company’s financial results for the second quarter of 2014. Carey?

Carey Hendrickson

Thank you, Larry. Good afternoon, everyone. Hopefully, you’ve had a chance to review today’s press release. If not, it is available on our website at www.capitalsenior.com. You can also sign up on our website to receive future press releases by email if you’d like to do so.

The company reported total consolidated revenue of $93.4 million for the second quarter of 2014, an increase of $6.2 million or 7.1% over the second quarter of 2013 with resident and healthcare revenue up $6.3 million or 7.4%. The increase in revenue is mostly due to acquisitions the company made during or after the second quarter of 2013.

Since the first quarter of 2013, we have acquired 14 communities, 11 of which contributed to our second quarter 2014 results and three of the acquisitions were completed on June 30, 2014 and therefore did not have an impact on our second quarter 2014 results.

As expected, the increase in second quarter revenue was partially offset by a decrease in revenue at two communities we’re repositioning from skilled nursing to private-pay AL and IL units. Operating expenses increased $4.5 million in the second quarter of 2014 to $55.6 million due to the acquisitions net of reduced expenses at the communities being repositioned.

General and administrative expenses for the second quarter of 2014 were $400,000 less than the second quarter of 2013 mostly due to lower healthcare expenses. Healthcare expenses were $600,000 lower than the second quarter of last year when we had an abnormally high level of medical claims expense.

Excluding the $700,000 of transaction and other one-time costs, G&A expenses as a percentage of revenue under management were 4.3% in the second quarter of 2014, which is 90 basis points lower than the comparable measure for the second quarter of 2013 and 60 basis points lower than the first quarter of 2014.

In the press release, we noted that the company’s non-GAAP and statistical measures exclude the two continuing care retirement communities that are being repositioned as well as one of the properties we acquired in 2013, which is now in the process of lease-up after recently receiving an upgraded license.

Adjusted EBITDAR, which excludes these three communities, was $32.2 million in the second quarter of 2014, an increase of $2.1 million or 6.9% from the second quarter of 2013. The company’s adjusted EBITDAR margin was 35.6% in the second quarter of 2014, which is 110 basis points higher than the second quarter of 2013 and 90 basis points higher than the first quarter of 2014.

Adjusted CFFO was $9.9 million or $0.35 per share compared to $9.5 million or $0.34 per share in the second quarter of 2013. The contribution to CFFO from communities acquired during or since the second quarter of last year, excluding the one community in lease-up, was $0.05 which is in line with our expectations and public announcements related to these communities. The contribution from same communities was $0.04 less than the second quarter of last year.

Same community revenue increased $600,000 or 1% over the prior year in the second quarter while same community expenses were up 3.5% resulting in a decrease in the contribution of same communities to adjusted EBITDAR and adjusted CFFO. The three major cost categories; employee, wages and benefits, food and utilities were well in line with employee cost up 2.9%, food cost up 1.7% and utilities up 2.4%.

Advertising and promotional expense increased $400,000 over the second quarter of the prior year as we continue to invest in initiatives to drive occupancy and revenue. While not significant components of our total operating expenses, repairs and maintenance and contract labor costs were also higher in the second quarter of 2014 as compared to the prior year, which contributed to the increase in same community expenses. As a point of information, we recently moderated the merit increase for employees going forward and the new rate will be in place for the next 12 months.

As Larry noted in his remarks, we’re pleased that our same community results showed significant sequential improvement over the first quarter of 2014. Same community revenues were greater than the first quarter by 0.6% with same community occupancies up 20 basis points to 87.1% and average rents up $22 or 0.7% to $3,141.

The sequential increase in average rate in the second quarter equates to a nearly 3% annualized rate increase which is more consistent with our growth goal on a same community basis. The conversion of approximately 360 units to higher levels of care is also expected to boost occupancy and rate once they’re completed. We’re making steady progress on the conversion and as Larry noted, we currently expect about half of the conversions to be completed by year end 2014 with the remainder completed in the first half of 2015.

Once completed, they must be leased up which is likely take six to 12 months. Based on these assumptions, we would expect the conversions to begin to have some impact on our operating results in the first half of 2015 with the impact growing throughout the year and with full impact of these conversions in 2016.

Looking briefly at the balance sheet, we ended the quarter with $39.4 million of cash and cash equivalents, including restricted cash. During the quarter, we received $36.5 million in cash proceeds related to refinance of debt on our 15 communities. We also invested $21.9 million of cash as equity to complete the acquisitions of three communities and spent $4.7 million on capital improvements.

Our debt balance at June 30, 2014 was 589.2 million at a weighted average interest rate of approximately 4.7%, down significantly from an average rate of 5.25% in the first quarter of 2014. The decrease in average rate was related to refinance of debt on 15 communities that we completed in the second quarter. The debt on these communities moved from just under 6% down to a blended rate of approximately 4.3%.

Also, the $40.1 million of debt for the Ohio JV communities was added at a blended rate of approximately 3.9%. All of our debt is at fixed interest rates except for six bridge loans that totaled $65.2 million, which were at variable rates averaging approximately 3.9%. And the average duration of our debt is now approximately seven years.

Speaking of the acquisition of the Ohio JV communities in which we previously held a 10% interest through a joint venture, please note that the community reimbursement revenue and community reimbursement expense on our income statement were related to that joint venture. Now that we’ve acquired these properties, these two line items will be zero going forward. This will have no impact on the company’s bottom line but it will reduce the absolute level of both revenue and expense for the company going forward.

There was also a small amount of affiliated management revenue on our income statement, which is related to joint ventures which will go away going forward as will the line for equity and earnings of unconsolidated joint ventures. The elimination of affiliated management revenue and equity and earnings of unconsolidated joint ventures will be more than offset by the consolidation of these operations into our income statement balance sheet.

Also, please note that one of the components of the adjusted CFFO calculation is shown on the non-GAAP reconciliation’s page of our press release, non-cash charges net, includes a few unusual items in the second quarter of 2014 that we would not expect to repeat in future quarters, including the $7 million write-off of deferred loan costs and prepayment premiums related to the refinance that we completed in the second quarter.

Also, we recorded a $1.5 million gain associated with our joint venture as a result of buying the Ohio JV communities which is also unique to the second quarter. Another component, stock-based compensation expense is higher than usual in the second quarter, which is mostly related to the accelerated vesting of stock awards due to the retirement of the former CFO. In future quarters of 2014, stock-based compensation expense should be more similar to the amount in the first quarter of 2014.

One of the components of non-cash charges net is the change in deferred income, which includes prepaid resident rent. Our current expectation is that the change in this component should be relatively flat for the remainder of the year. For your reference, the components of non-cash charges net can be found in the statement of cash flows in the operating activity section. It’s made up of all the adjustments necessarily to reconcile net loss to net cash provided by operating activities prior to the changes in operating assets and liabilities.

A couple of other items to consider related to the third quarter is that historically, our third quarter expenses have been higher than the second quarter due to summer utility costs and there is an extra day in the third quarter; 92 days in the third quarter versus 91 in the second quarter and 90 in the first quarter, so that will impact expenses.

Also, our third quarter results will include the three communities acquired on June 30 as well as about two months results for the properties we acquired effective August 4, which on a combined basis should contribute an incremental $0.03 to $0.0350 to CFFO for the quarter versus the second quarter.

That concludes our formal remarks and we would now like to open the call for questions.

Okay, great. Thanks. Just the question relates to your occupancy, you did have year-over-year gains, which was nice to see. I guess I’d love to just get some commentary from you about how you think that’s developed over the course of the quarter? And really I guess as it relates to the attrition topic, maybe update us on how you’re thinking about that and how it might impact your occupancy over the next year as we think about the outlook?

Larry Cohen

Sure, Darren. First of all, if you look at the second quarter on same store, we had a 12% gain in move-ins; 127 more move-ins. We had about 15% gain in independent living move-ins, 9% gain in assisted living. Our deposits were up 13.4% year-over-year and tours were up, as I mentioned, by about 9.5%. We also saw gains from the second quarter compared to the first quarter in move-ins. The gains were about 13.5%, deposits were up approximately 16%. So we’re seeing good trends from the initiative that we have implemented this year some of which are increasing our costs, especially as it relates to referrals, advertising, pay per click, community call centers. On our (indiscernible) for example, we now increased our referrals and move-ins by about 41%. The good news is we’re taking market share, but obviously these are prospects that have other choices and are selecting Capital Senior Living. So I’m encouraged by the continued improvement in the third quarter over the second quarter. We’re seeing continued trends upwards in all of our metrics. Deposit taking is up, deposit move-ins, we’re kind of seeing trends now so far in the first month of the quarter of about 6% from the prior year, so August is showing continued positive trends. So we’re expecting to see third and fourth quarter typically has the best occupancy growth during the course of the year. As we said last quarter, we forecast flat occupancy gains in the first quarter. We picked up 20 basis points this year on a same-store basis. 20 basis points for the second quarter is very much in line and we expect to see that improve in the third and fourth quarter. So, we think that we’ll continue to see the occupancies. Attrition in the first quarter was fairly moderate. It picked up in the second quarter. Hopefully, we’ll get back to kind of normal levels. It’s somewhat out of our control. And as we spoke about to something that we’ve identified starting last year with the initiatives on conversions, we have 360 units that we expect to be licensed through the first half of next year and a half of that be completed this year. We’re now looking at hundreds of additional units for the second half of next year, so we’re working to planning on that right now. So we think that the initiatives we have done, we’re encouraged by obviously better traffic, better move-ins, better deposit taking. We’re sitting with a very nice net deposit gain coming into this quarter which has grown in the month of August. So we’re hopeful that will continue to trend over the next 60 days, that net move-ins versus notices for move-outs, so the trends should improve throughout the quarter. And our experience has been over the last couple of years that if we end strong in the third quarter, it typically results in a positive fourth quarter as well. I hope that gave you some color, Darren.

Thank you. So just a follow up. The color you gave towards the end of the prepared remarks about what you called some unusual items that impacted CFFO. Can you quantify how much the impact would be overall to CFFO pressure from all these items?

Carey Hendrickson

Yes. Well, so they really don’t have – I just wanted to make sure you and point out to you that they were in that $20 million of non-cash charges net. They don’t have impact on CFFO directly because they – for instance, the $7 million loss it’s in that $7 million loss number when you back it out in the adjustments to CFFO, same thing with the gain. It doesn’t really end up impacting the bottom line CFFO but I wanted to just note that those things were in there. So they don’t have specific impacts on it but again, I just wanted to make sure you know it. And same thing with stock-based comps, it’s in the loss number but it comes back out as an add. I just was clarifying that.

Joanna Gajuk - Bank of America Merrill Lynch

Okay. And then also on the one facility that you – excluding from the consolidated and same-store numbers into lease up, what’s progressed I guess in the revenue or EBITDAR or whatever you can give us in terms of the metrics for that facility that’s coming out from…?

Larry Cohen

Joanna, it’s almost neutral. The EBITDAR contribution is very insignificant. This is a property that was acquired last year. We took a bridge loan when we made the acquisition in the third quarter expecting to enhance the license of the building. The license was received this quarter. In the meantime we stopped admitting residents and actually moved residents out because we thought they were inappropriate for the licensure that the building had at that time. So because of a fact that we saw the kind of change in operations at that community, we decided to take it out from our numbers. If you look at EBITDAR, it basically breaks even. So it really has almost no change in the numbers by taking it out. We just thought it gives better clarity to the operating metrics that we discussed by not including that property because of its occupancy and the fact that we are now releasing that building since we have received necessary license.

Joanna Gajuk - Bank of America Merrill Lynch

And then the last question on the same-store expense growth that was 3.5% year-over-year but still a good (indiscernible) some of these numbers that were impacting there, but as far as I can remember in Q1 excluding the weather impact, same-store expense growth was only 1%. So was there any acceleration in some of these cost items Q2 versus Q1? And also are the higher referral fees that you called out in Q1, are they still impacting Q2 numbers?

Carey Hendrickson

Okay. Let me talk briefly about same-store expenses in the second quarter and kind of comparing it to the first quarter, they were actually better than the first quarter by about $400,000. We had an extra day of expense for one thing in the second quarter. We had 92 days in the second quarter versus 91 days in the first quarter and that affects your labor costs, your hourly labor, you food, your utilities. It’s usually somewhere around $500,000 is what that means per quarter. Utilities which were – we noted were up in the first quarter by about $1 million, they were down by about $1 million in the second quarter versus the first quarter. But as I’ve said, labor and food costs were higher and a lot of that offset some of the decrease in utilities. We did also looking at the line where we talked about the weather-related items like snow removal cost, those kinds of things, we did have lower service contract costs in that line in the second quarter versus the first quarter where it kind of took those out. So those things normalized pretty much in the second quarter other than the extra day of expense. So, the second quarter I think is a pretty good base of expense from which to begin as we go forward.

Joanna Gajuk - Bank of America Merrill Lynch

Okay. I’ll go back to the line. Thank you.

Carey Hendrickson

Thank you.

Larry Cohen

Thank you.

Operator

(Operator Instructions). We’ll take our next question from Daniel Bernstein with Stifel.

Daniel Bernstein - Stifel, Nicolaus & Company

Hi. Good evening.

Larry Cohen

Hi, Dan.

Daniel Bernstein - Stifel, Nicolaus & Company

Hi. I have a question. How disruptive are the conversion in CapEx that you’re putting into the properties? Is that impacting your ability to move occupancy or rates or anything else with your properties?

Larry Cohen

Actually once we start the CapEx, it actually helps because we’ll have pictures in the lobby showing the work being done and you start getting some enthusiasm there. So it’s really not disruptive. In this one case it was a licensor issue where we bought the building, we knew that it didn’t have the appropriate license. It took us longer to process, to get the license when you’re dealing with surveyors and fire marshals, et cetera. It took a little longer than we anticipated but we have the license now. So that building was somewhat unusual where we had to basically stop admissions and increase staffing during that period of time until we got the appropriate license. But for these other conversions, as we start elsewhere with the exception of a major rebuild like Veranda Club which is unusual, most of these conversions, probably 90% there’s almost no CapEx required. We’ve already gotten in Ohio, Indiana, [the states] (ph) of a licensing independent living, assisted living. We already are compliant with building codes, so now it’s tweaking some systems, life safety issues, things like that during that process but it’s not – we don’t expect to be disruptive at all. The experience we had in the three Ohio JV properties that we acquired, we went through this in 2010, 2011. We were licensing in 10 to 15 increments. They kept filling very quickly and there was absolutely no disruptions. So I don’t expect to see disruption with the exception of a building like in Florida where again it’s easy there, it’s a separate building. We closed that building. We did the construction, takes about six months; reopened it. It doesn’t affect the rest of the property but these other conversions I don’t expect to see any impact in our normal operations.

Daniel Bernstein - Stifel, Nicolaus & Company

Do you think the AL units that you’re – I guess the ones you convert, are you pricing those units at what you think were assisted living in market – that market within those geographies or you able to undercut competitors for a similar quality property?

Larry Cohen

Well, the good news is we get market because we have something the competitors don’t have. We have large apartments, one and two bedroom. The Boca Raton experience was very interesting and the reason we’re doing phase II was because of the strong demand. The only assisted living in that market with large units is our property. So what’s happened is we got discounting. We don’t have to discount. We’re able to get full rates on the market rates particularly – so the value we’re offering is a larger unit for the same price by coming into a converted unit compared to the market. And we’ve seen that across all the buildings that we’ve converted in.

Daniel Bernstein - Stifel, Nicolaus & Company

Okay. That’s good to understand. And then in the quarter, how much was the extra non-stock comp or retirement cost for Ralph?

Carey Hendrickson

It was just over $1 million, $1.1 million.

Larry Cohen

Yes. What happened is his non-invested shares vested under our plan because he retired over the age of 65.

Daniel Bernstein - Stifel, Nicolaus & Company

In your normalized AFFO, are you taking that 1.1 million out or is that…?

Carey Hendrickson

Yes. So it’s in that net loss number then we add the whole amount of stock-based comp back in the AFFO calculation. So the AFFO is not really impacted by stock-based compensation.

Daniel Bernstein - Stifel, Nicolaus & Company

Okay. And then one or two more questions, if I can.

Larry Cohen

Sure.

Daniel Bernstein - Stifel, Nicolaus & Company

We hear a lot about wage inflation starting to creep in I guess in the national economy and I’ve heard it from a few of your peers both public and private. Are you seeing wage inflation or you’re expecting wage inflation? Then secondly, as a result, is this the right time to I guess hold back on wages for your employees? Are you worried about attrition from employees going to some place else?

Larry Cohen

Well, we’re still have increases in wages. We just moderating that increase. Our wage increases have been 2.5% to 3%. We’re coming down slightly from that, so we don’t think it will have an impact because there will still be an increase to our employees. And if you think about the math on a weekly by weekly or monthly type of payment, we don’t think it will have an impact.

Daniel Bernstein - Stifel, Nicolaus & Company

Okay.

Larry Cohen

I think it’s the cumulative effect to 6,000 employees that save the company quite a bit of money but we think to the corporate and property level staff, there are still going to get increases that we think are attractive. It’s just that we’re moderating the growth of those increases.

Daniel Bernstein - Stifel, Nicolaus & Company

Okay. And then on the pipeline closing almost 150 million or expect to close almost 150 million before the end of 3Q. Can you talk a little bit more about the size of the pipeline that you’re looking at? Is it all assisted living? Is it still continuing to be in some of these one-off transactions or are you looking at anything larger at this point?

Larry Cohen

It’s a combination. We have a very active pipeline of single assets. We actually just made an offer today on a property that we actually – it’s interesting, it was a two property opportunity. We made an offer on one. The seller was uninterested in selling because he didn’t like the offers on two. He just got an offer on the second building we didn’t want to buy, so we came back today and made I think a very competitive offer. There are some larger transactions that we’re looking at and we’re working on that could be larger than what we’ve done in the past, but again there is no way to handicap whether or not or when that may happen. This transaction that we’ve been talking to a potential seller for some time, we’ll see. So it’s a mix if you look at that but again, as I said earlier, about 90% of the activity that we’re involved with is off-market. We’re very pleased that we’ve had a good pace of acquisitions, have really benefitted from lower interest rates. Obviously, there’s a lot more competition from lenders today with life companies and the agencies that have definitely helped us in narrowing spreads as you saw on the pricing of the refinancing we did in June and the recent acquisitions. So we’re excited about that. So we’re going to continue to be very disciplined in our acquisitions. We’re not going to give guidance but feel that we have plenty of opportunity and we think that we have increased our liquidity and we’ll be able to continue a successful program.

Daniel Bernstein - Stifel, Nicolaus & Company

Okay. And it’s mainly AL at this point?

Larry Cohen

It’s definitely AL, yes. The acquisitions we’ve closed, yes they were all AL. Small IL but mostly AL.

Daniel Bernstein - Stifel, Nicolaus & Company

Okay, all right. I’ll hop off. Thank you.

Operator

Thank you. We’ll take our next question from Todd Cohen with Mtc Advisers.

Marc Todd Cohen - Mtc Advisers

Good afternoon.

Larry Cohen

Hi, Todd.

Marc Todd Cohen - Mtc Advisers

Larry, you referenced as part of your strategy early in this call that you wanted to drive occupancy and rates with a couple of initiatives. I guess you indicated you wanted to drive occupancy at some of your lesser profile IL properties with maybe some type of promotions and that you were looking to increase rates at your better occupied properties. Can you talk about that a little bit more?

Larry Cohen

I think you actually explained this extremely well. That’s exactly what we’re doing, Todd. We have been giving some introductory promotions at the lower occupied independent living. It typically is for a short period of time and then it burns off and goes back to a rate, so we’re building future revenue over some time. The average month of stay of independent living is 31 months. So if we give a slight reduction in the early months of that lease term, we think we capture it. It does have an impact in this rate growth we’re talking about in Q1 and Q2 because it does – for example, we had some promotions in December with bad weather and obviously that impacted the first three months of the year and then we saw revenues pick up again. So as we periodically have these promotions, it’s targeted to these weaker performing and I would tell you we’re seeing very strong results. The hope is that as those occupancies gain and occupancies strengthen that we can start eliminating those conceptions and start driving better rate growth. At the same time, we have looked at our green buildings. They’re 90% of greater. It’s interesting, Todd, just to give you some point of reference. Year-over-year, our yellow and green build properties which is probably about 75%, 80% of our portfolio year-over-year second quarter to second quarter averaged occupancy gains of probably around – almost 2% and rate gains of 2.5%. We’re seeing the loss which is up 3.3% year-over-year within those red zone buildings with 1% rate growth. So the good news is that we’re seeing the green get greener. The count of our green continues to grow. The good news is the red zone as of today, we just got our numbers in for last week is the highest occupancy level I’ve seen in years. So, we’re seeing improvement in those properties and we also have selective sales contemplating us well. So we have a strategy that’s focused on do we have the right people? If not, make a change. Do we have the right physical plans? Do we need to update and modernize that? Do we need to convert units to provide more levels of care for aging in place? If it’s the market, it’s a good market to sell into and we’re happy to take some very good properties that we feel could get attractive pricing and then take those proceeds and redeploy them to more core investments. So we are again – we prefer older buildings. We’re 90% occupied but they’re not and we’re taking actions to remedy the situation which we think will be very productive and profitable for our future.

Marc Todd Cohen - Mtc Advisers

And then, Larry, just again on this IL side, I believe you’ve discussed publicly that you got some assets that are for sale. I’m assuming it’s the IL and I was just kind of wondering are those the properties that you’re focused on with those promo sales and is that also where you’re spending CapEx?

Larry Cohen

We have not been spending CapEx there. I mean that’s nothing unusual. There are in good shape, they’re in good conditions, they have good staff. They’re in markets that don’t drive the type of returns that we see elsewhere. So they’re selectively being disposed off in order to enhance the overall performance of the company. We did have some promotions at some of those buildings to get the occupancies. They’re done now but again we did do that in anticipation of the sale. So there was some promotion. That obviously is a very good question because those will go away. I think that the maintenance CapEx that we incurred there are as a regular CapEx. Again, the feedback we received from the buyers and other interested parties was very positive about the physical plant, extremely complementary about the staff. So they’re well run and we wish a buyer extremely – a lot of success for the building. We’re happy to see them continue with the operations, with the great staff. It’s just a function that we feel that we’re getting better returns on other assets that we own or other properties that we can acquire.

Marc Todd Cohen - Mtc Advisers

So, Larry, are these assets in effect sold at this point and it’s just a matter of the time right now?

Larry Cohen

They are not sold. There’s a due diligence process. And our plan is to have them sold this year but they are not sold yet.

Marc Todd Cohen - Mtc Advisers

Okay. And then I know that there were some tax benefit potentially that you guys were going to accrue this year. Can you just talk about the status of that?

Larry Cohen

I don’t think so. My recollection is that we took the cost segregation study, we recognized the full value in the fourth quarter of last year and I think that’s pretty much done with it. We do a cross allocation when we buy buildings but there’s no initiatives I’m aware of to create any – that we have an NOL that will carry forward many years. It actually has increased by the prepayment penalty on the refinance. I’d just like to clarify that that refinance absorb the cost of the penalty, so that was rolled into the new loan in addition to the $36.5 million of cash we took out from those loans. So there was no use of cash to the company for that. But it’s just the fact that we have a carry back – we do have almost a $4.5 million cash refund that we’re...

Marc Todd Cohen - Mtc Advisers

That’s what I’m referring to.

Larry Cohen

Yes. The tax refund will be filed to returns this summer and we expect the tax refund I believe in October.

Marc Todd Cohen - Mtc Advisers

Okay. Yes, that’s what I was referring to.

Larry Cohen

The tax refund is still – again it comes I think in October.

Carey Hendrickson

But that does not affect the P&L. That’s a tax refund but it does not affect the P&L.

Marc Todd Cohen - Mtc Advisers

No, I know. It affects the balance sheet.

Larry Cohen

So it’d be cash that have more liquidity…

Marc Todd Cohen - Mtc Advisers

Okay. And then Carey for you I have the question. You’re the new guy in town and obviously you’ve taken a lot of time here to I’m assuming look at a lot of the property level type operations and expenses. And I was wondering with new eyes looking at this portfolio as to whether or not you see respectable opportunities in terms of maybe new tools for the executive directors and the financial people on site and whether or not there is some opportunities there for more productivity and efficiency again with new eyes?

Carey Hendrickson

Thank you for that. I’d say what I found actually is that the company has very good tools in place. They have – obviously the main three expenses are labor cost, food cost and utility cost. We have very effective processes in place to control food and utilities and labor is something that varies with the market by market and what the needs are in those communities as it relates to IL and AL. Certainly, Todd, we’re taking a look at all of that but I think for the most part what I have found, I’ve been very encouraged by the fact that the company has good tools in place related to that. I think that’s evident by the expense growth they’ve seen over the past couple of years has actually been very modest expense growth. We have had some expense growth in the first two quarters this year that’s been greater than usual but it’s been a very modest expense growth in the last prior couple of years. So I think that speaks to their effective cost control.

Marc Todd Cohen - Mtc Advisers

Great. Thank you.

Operator

We’ll go next to Dana Hambly with Stephens.

Dana Hambly - Stephens Inc.

Hi. Good afternoon. Thank you.

Larry Cohen

Hi, Dana.

Dana Hambly - Stephens Inc.

Larry, could you go back to the acquisition that you made last year that you pulled out of the same-store results. I’m not sure that you needed to get a relicense. Is that something you knew going into the acquisition?

Larry Cohen

Yes. If you read the press releases, we took a bridge loan. It was in the press release that we were – in terms of bridge because we were seeking a higher license for that property. We knew that.

Dana Hambly - Stephens Inc.

Okay. So it’s now been relicensed. That should come back in after it’s leased up and that’s six to 12 months?

Larry Cohen

That should be probably within six months.

Dana Hambly - Stephens Inc.

Okay. Are there any other assets that you bought that we should be looking that would happen to or is that an isolated…?

Larry Cohen

No, that is the only one that we actually knew when we purchased it that we wanted to enhance the license from where it was. We started working on it at the time of acquisition and it was then because we expected that to be the case.

Dana Hambly - Stephens Inc.

Okay, all right. And then just on the reposition CCRC’s, it looked like they were a positive contributor to consolidated adjusted EBITDAR, about 400,000. I think they were negative the last couple of quarters. Is that just an indication that they’re starting to come on line and kind of once you get all that done in the fourth quarter, it should immediately be accretive?

Larry Cohen

Yes. Those properties – the assisted living performs well. We obviously have some opportunity in independent living. Part of the conversion strategy is in addition to adding the memory care units in the skilled nursing space which is out vacant, we are in the process and hope by the first quarter of the year to have converted some of the independent living units to AL and these memory care units. So it’s moving along but the rest of the building operationally is positively cash flowing. Again, it’s not at the level we expect to have tremendous opportunity. When you look at the number of units in these two buildings combined, so we think we can add significant value and cash flow. But even though they’re out of our numbers, they do contribute positively to our EBITDAR and to the cash flow.

Dana Hambly - Stephens Inc.

Okay. And – go ahead, Carey.

Carey Hendrickson

We’ve got the repositioning going on, on one side and then we also are doing conversions at these units as well, so the IL to AL. And as Larry mentioned, just on the repositioning part where we’re adding these memory care units we expect – Larry mentioned starting construction in the fourth quarter and done by the middle of next year is what we expect. So then you’d need to lease some up which would be the six to 12 months. So from a timing standpoint just to give you some feel for that, I’d say we’d expect to see some impacts on our results in the second half of 2015 related to the repositioning and then more in 2016.

Dana Hambly - Stephens Inc.

Okay, all right. That’s helpful. And then Carey, I appreciate all the color you gave on the different line items. Maybe I could just ask one more from you on the interest expense line, 7.4 million in the quarter. Is that the run rate we should be using or is it a little bit lower from the refinancing you just did?

Carey Hendrickson

No, I think that would be about the right run rate, actually our interest expense related to financing. Even though it was a greater amount of debt, it was at a lower rate. The interest expense related to that was 15 communities stayed the same. We did reduce our overall debt service payment because we extended the amortization from 25 years to 30 years on those communities. But from an interest expense standpoint that should be the run rate.

Larry Cohen

Yes, well, speaking of that $1 million of less debt service as that’s a positive to cash from the less amortization but I think the interest as Carey said will be neutral.

Dana Hambly - Stephens Inc.

Okay, all right. And then lastly from me, Larry, you talked a little bit about some of the incredible rates you guys are getting right now. Obviously no one knows what interest rates are going to do but right here right now you kind of feel like if all things being equal that we could kind of see rates in 7.5% for a loan?

Larry Cohen

Well, I’m not an economist but I would tell you that we are very pleased to see the spreads narrow considerably. It’s interesting we did the financing in the first quarter, I believe it was 5.49.

Dana Hambly - Stephens Inc.

Right.

Larry Cohen

When we did the refi, I thought we’d be refinancing about 5.5%. It was more the sense of anticipating the potential for higher rates in the second half of 2015. And through this process we saw better competition and interest rates, the 10-year came down. The 10-year today is less than 2.50. Spreads has narrowed, so yesterday’s low was 4.59. The refi for SO, AL and IL were less. So I think right now we’re very comfortable that rates should stay under 5% for the near term.

Hi. Just a follow-up question in terms of the comment you made about August, I guess positive trends you saw in August and your previous commentary around the outlook for the year for occupants to be up 100 to 150 basis points and rates to be up 2%. So is there any change to that outlook for the year?

Larry Cohen

On a consolidated basis, we picked up I think 50 basis points first half of the year, same-store 40 basis points. Based on the activity we’re seeing today for the first month of the third quarter, deposits and our history, I would expect that if we can continue to grow at a slightly higher pace in Q3, Q4, we should be over 100 basis points. Again, it’s not the average for the year, it’s from the beginning of the year to the end of the year that growth. So the average of the year won’t be 100 basis points. It’s where we end the year compared to where we start the year. The same thing with the rate growth. It won’t be a flat 3% for the year, it’s where rates end compared to where they start. And as Carey mentioned in the second quarter, sequentially we’re running on an annually basis of about 3% and our hope is to continue that over the balance of the year.

Carey Hendrickson

So, Joanna, I’d look at it on the revenue side from a sequential basis from second quarter to third quarter, our goal would be to grow that at a rate similar to what we did sequentially from the first quarter to second quarter. So I would really kind of start with second quarter rate and go forward from there on kind of the annualized 3% basis. And then from an expense standpoint, you did ask about that too. I noted in my remarks that we do expect third quarter expenses to be affected by higher summer utility costs and then also an extra day of expense versus the second quarter. So sequentially looking from second quarter to third quarter, there will be increases related to that. But we’ve also moderated our weight increase for the next 12 months and our goal is try to keep the expense growth to that 2% level on a same community basis other than the summer utility costs and that extra day of expense because that will be an impact on that.

Joanna Gajuk - Bank of America Merrill Lynch

Great. Thanks.

Operator

We’ll go next to Daniel Bernstein with Stifel.

Daniel Bernstein - Stifel, Nicolaus & Company

Hi, guys. One follow-up question here. You’re really becoming more of an assisted living company with the acquisitions and the conversions. So I was trying to understand, are you having any additional operating expenses for training, hiring higher level nurses so forth? And then a related question is, how should I think about operating margin? We’d go out 2015, 2016, you talked about 350 with occupancy but traditionally assisted living has been a little bit lower operating margin in IL. So I’m just trying to understand how your expense patterns are changing?

Larry Cohen

Well, let me talk about training. We do have a third party for training for all of our caregivers in AL. That cost is not going to be significant as to – it won’t affect your forecast on CFFO or anything else. It’s going to be less than half a penny for a year. So that should not be significant. One thing we do see, Dan, and I think one of the opportunities we have is as we are evolved in more assisted living, we have had more contract labor. That’s something we’re very focused on to make sure that we are hiring the right nurses, nurses aid, staff in the care setting because we want to minimize contract labor. We saw that in the first and second quarter. That’s something we’re seeing in our labor costs that went up. So there’s a lot of focus there and I think that we can get that under control. If you look at this quarter where our operating expenses were, it’s probably decent memory, as Carey said. It’s a pretty clean quarter looking at that level, the expenses were 59.5% of revenues. EBITDAR margin was up 110 basis points over last year. Obviously G&A was well controlled. And on the acquisitions, the good news is we’re buying – one thing about occupancy, the operating leverage even in assisted living every dollar of incremental revenue whether the IL or AL generates a $0.70 contribution to EBITDAR. So if you think about the – really as I look at this, if we’re successful in growing occupancy even though our cost may be higher because of more assisted living, the margin I would think would still improve because you’re getting the operating leverage into those buildings through the higher revenue source.

Daniel Bernstein - Stifel, Nicolaus & Company

Okay, all right, I appreciate it. I’ll hop off. Thanks.

Larry Cohen

And on the conversions we’re expecting the contribution to be at $0.60 on the dollar, on same-store it’s about $0.70 on the dollar.

Daniel Bernstein - Stifel, Nicolaus & Company

Okay.

Operator

We’ll go next to [Vineet Vijay with Bruce Heart Capital.]

Larry Cohen

Hi, Vineet. How are you?

Unidentified Analyst

Hi, guys. Can you hear me?

Larry Cohen

Yes, we can.

Unidentified Analyst

Okay. Thanks for taking the question. Larry, you mentioned previously rates are at historical lows. Is there any opportunity on any of the other mortgages that you guys have coming due over the next six to 36 months where you can refinance those today and strip out some excess proceeds?

Larry Cohen

There is opportunity. We’re looking at them right now. As Carey said, the average maturity now is over seven years. We do have some loans that mature over the next couple of three years where there is equity and there’s value and it’s actually something we’re looking at to our prepayment penalties and yield maintenance. So we have the kind of measure, the cost of the refinance versus the benefit but it’s something we are very focused on Vineet.

Unidentified Analyst

Got it. And with the proceeds, if you are able to do anything in that scenario, the proceeds would be used for further acquiring other assets I would imagine, correct?

Larry Cohen

For refurbishing buildings, again for corporate purposes. So where we are allocating our capital is acquisitions, refurbishment and conversions. So we’ll be in one of those pockets. It will be somewhere where we think we can create value and enhance cash flow.

Unidentified Analyst

Got it. And then the last question I have is given kind of where debt rates are today and financing is today for the product, you guys are buying in the product that you already own. Where would you say market cap rates have trended for the underwriting that you’re doing when you’re buying an asset today? Since you’re buying owned assets on our balance sheet, how should we think about what’s the cap rate that you’re looking at on new acquisitions today?

Larry Cohen

Well because some of our buyers listen to these calls, we don’t talk publicly about cap rates, I hope you appreciate that. So I rather not answer that because I may get in trouble. So if you look at the numbers now, I think we’ve still been – cap rates have definitely come down. I think we still have been buying properties at a very attractive cap rate. What’s interesting, a cash on cash return on our 2014 acquisitions is over 17% and the lower financing costs definitely helped. And then obviously if you read the NAVs from the analysts or other kind of valuation metrics, clearly there’s a lot more interest in this sector and it’s having an impact on cap rates.

Unidentified Analyst

So would it fair to assess that wherever the analysts NAVs were a year ago, they’re substantially higher today you’d say or higher today?

Larry Cohen

I would think they should be higher today because they should I would think be using a lower cap rate on the NAV, yes.

Unidentified Analyst

Great. Thanks guys.

Larry Cohen

Thank you, Vineet.

Carey Hendrickson

Thank you.

Operator

We have a follow up from Todd Cohen with Mtc Advisers.

Marc Todd Cohen - Mtc Advisers

Yes. Larry, on that property that you guys have pulled out from the results, the IL property. I think you said you’ve kind of taken that off the books. Can you refresh me as to what’s going on there? This is the one with the bridge loan.

Larry Cohen

Yes, when we bought the building it actually is AL but it has a low level of AL. There’s a higher level of AL licensor that is necessary for the acuity on some of the residents that were there. While we were waiting for the license, we moved those residents elsewhere because we didn’t think it was appropriate for them to be in that building.

Marc Todd Cohen - Mtc Advisers

Larry, did you say it was predominately IL or AL?

Larry Cohen

There are different levels of AL licensor. In this case it didn’t have the heightened AL license that we would want for that building. There were services being rendered but it was limited. So, therefore, we have now received the appropriate license for the building and are now – going back now and looking to refill those units with the appropriate niche of services to the level of needs of the residents.

Marc Todd Cohen - Mtc Advisers

And so the occupancy metrics were pulled out of the results because of that?

Larry Cohen

It’s not a same store because it was purchased after the second quarter, so it does not affect any of the same-store results. It’s just on the supplemental schedules looking at kind of our – and again, it’s a small piece of our – I think it’s less than 50 units, so it’s a small building. So again, it’s not going to really impact much. We just thought that it was easier to take it out because of the fact that many of the units were out of service basically until we receive the license.

Marc Todd Cohen - Mtc Advisers

A lot of the units were taken out of service.

Larry Cohen

Half the units, yes.

Marc Todd Cohen - Mtc Advisers

Half the units, okay. So half the building is not occupied?

Larry Cohen

40%.

Marc Todd Cohen - Mtc Advisers

Okay. So that should start to kick-in. And then just one last question. You’ve given us an indication of what closings you’re going to have potentially in the third quarter. Is it safe to assume that you guys are still moving ahead with acquisitions going into the fourth quarter? You didn’t talk about that but I’m assuming that there should be some. Is that assumption okay?

Larry Cohen

Well, what we said in our release and what I said in my comments is we’re conducting due diligence on additional transactions, so hopefully we’ll have more in the fourth quarter.

Marc Todd Cohen - Mtc Advisers

Okay, great. Thank you.

Larry Cohen

Thank you, Todd.

Operator

It appears there are no further questions at this time. Mr. Cohen, I’d like to turn the conference back to you for any additional or closing remarks.

Larry Cohen

Thank you very much. I want to thank everybody for your participation today. Welcome Carey and congratulations on your first call.

Carey Hendrickson

Thank you.

Larry Cohen

And again, please feel free if you have any follow-up questions to call Carey or myself. Have a great evening and great rest of the summer and we look forward to seeing you I’m sure of any conferences coming up after Labor Day. Thank you very much. Thank you. Bye-bye.

Operator

This concludes today's conference. Thank you for your participation.

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